The Bank of Israel published its latest annual review at the end of May¹.The review includes an announcement by Supervisor of Banks Yair Avidan that he is promoting the formulation of updated comprehensive regulations on environmental risk management, considering the considerable importance he attributes to the subject of the environment.
Already at the end of 2020, the Supervisor of Banks sent a letter to banking corporations and credit card companies advising them of the initiation of a process of regulating and supervising banks’ environmental risk management². These clear statements may have significant implications on many business entities, adding practical substance to the growing discourse about corporations’ environmental impact and their adoption of an ESG policies.
Significance of the Regulation
At issue is a significant expansion of the regulatory actions that began back in 2009, when banks were required to identify and assess their environmental risks as part of their risk management. Since 2009, banks have been required to publish reports about the way they manage their environmental risks, as well as corporate responsibility reports that reflect, inter alia, how they incorporate social and environmental considerations in their decision making.
In its annual review, the Bank of Israel states that the Paris Agreement and the climatic phenomena occurring in various regions throughout the world have heightened the global focus on climate change as a major environmental problem that requires addressing now, also within the financial context.
When analyzing banks’ exposure to climate risks, two categories have been identified. The first is the physical risks deriving from concerns about banks taking a direct hit from climate change phenomena, such as fires, floods, storms, etc. The second is evolving risks deriving from the impact of climate change that require adjustments to be made, such as policy changes, the adoption of green technologies, changes in market preferences, a shift to a low-carbon economy, etc.
Thus, the Bank of Israel is emphasizing that environmental risks have financial and nonfinancial impacts on banking corporations. Indeed, sometimes they are part of the risks a bank already manages, such as credit risk, market risk, operational risk, compliance risk, legal risk, reputational risk, and liquidity risk, which, under extreme circumstances, can also deteriorate into a stability risk.
The Bank of Israel also emphasizes the need to manage these risks with a long-term perspective as dictated by the nature of the risks deriving from climate change.
Environmental Risks: International Activities
As part of its supervisory preparation, in October 2020, the Bank of Israel became a member of the Network for Greening the Financial System (NGFS). This network of central banks and supervisory authorities works together to make the financial system greener. The NGFS published a series of recommendations for contending with climate risks that are expected to be used as a foundation for banking regulations relating to these issues.
The Bank of Israel also reported in its annual review that the European Central Bank (ECB) announced that the “major banking entities” directly under its supervision would be asked in 2021 to examine their fulfillment of the expectations the ECB published in relation to climate risk management and to formulate action plans accordingly. In 2022, the ECB will conduct a full supervisory review of banks’ work methods and will take measures if needed.
During one of his speeches in September 2020, the Supervisor of Banks also stated that he considers banking corporations to be important partners during the transition to a sustainable green economy. He added that this is an opportunity for the banking system to play a more significant role in the socioeconomic fabric of society by identifying, financing, and promoting initiatives that have a positive social impact³
In order to encourage banking corporations to channel capital to the financing of “green” initiatives, the Bank of Israel’s annual review also refers to a research performed by a group of researchers from universities in Israel and Hong Kong that found that banks that adopt policies based on environmental and social principles may create value for companies that borrow from them. The research supports the hypothesis that companies can reduce their debt and equity prices by committing to ESG policies and engaging in loan contracts with banks also committed to socio-environmental principles⁴.
It seems the measures the Bank of Israel is planning—to encourage and even mandate banks to develop an appetite for environmental risk, to adjust their credit policy, and to channel investments to fund green initiatives—may have an impact not only on the banking corporations it supervises but also on their various customers. This demonstrates why these developments are important to the entire business sector that should plan and adjust for these developments.
⁴Amiram Dan, Gavious Ilanit, Jin Chao and Li Xinlei, The Economic Consequences of Firms’ Commitment to ESG Policies, February 2021. Available at SSRN.